When funding a new business there are two
types of funding sources, internal and external.
Internal funding is the cheapest method
of funding as you are not relying on the
external market.

External funds are those that come from
outside of your business and may come from
Banks, commercial lenders, your Franchisor,
suppliers or venture capitalists such as
Business Angles.

When
funding your venture you should always look
to internal funding first. Most businesses
us a mixture of both. The advantages are:-

Using internal funds lowers the cost of
gaining external funding.

Lenders like to see that the business
owner has some “hurt money”
invested in the venture. This shows a
greater commitment from the business owner
to the business.

It is unlikely that a lender will give
you 100% funding. If they do then they
will want ownership of the business.

Importance
of internal/self funding

In
most cases a business is started out of
the cash reserves of the owner. For small
business most financers will not lend unless
the owner/s have a vested interest in the
business. If you are unwilling to commit
some of your own funds into starting the
business then it is unlikely that a lender
will and it may be that you need to re-assess
the idea of going into business.

While some lenders will lend a larger amount
they will ask for greater returns to match
their greater risks. This will result in
high interest rates or an equity stake in
the business. The result is that you may
not risk your money initially but in the
long term you risk having ownership of the
company that you have built..

When assessing deals lenders will look at
key ratios such debt/equity and times interest
cover. The less that you have to borrow
then the better that these ratios are and
greater your opportunity of gaining funding
and the lower the cost of borrowing.

External
Financing

Debt
financing is the most common way of raising
money and it is usually in the form of the
borrower receiving a loan based on security
of some sort being offered. When the loan
is repaid the security is released. If the
loan goes into default then the lender will
call on the security to repay the debt.

There
are various types of security that can be
offered:

Residential real estate:-
This is a favourite of Australian Banks

Commercial
real estate:- The banks
will lend less to this as often it has
been built for a “special purpose”

Guarantor:-
May come from a relative, supplier or
franchisor. The guarantor signs saying
they will step in if the loan goes into
default.

Equipment:-
Often these loans are in the form of leases,
Hire Purchase or Chattel Mortgages

Finished goods:-
The value of stock for retailers

Debtors List:-
The lender will advance money based on
the value of your receivables

Business Assets:-
In the case of certain franchise systems
in Australia the lenders will lend against
the assets of the business / new business
including the good will.

While
banks have been wary in lending to new businesses
in Australia they have shown that they are
starting to understand franchising and regard
franchise businesses start ups to be lower
risk than other forms of small business
start up and as such most have a franchise
lending policy

When
assessing the deal the lender will assess
both you and your business model. Therefore,
you will need to be prepared to supply both
business and personal data. When applying
for a loan based on an accredited system
you will need to supply a business plan
and a projected cash flow analysis and personal
debt position.

The
franchisor is also a potential source of
funding be it in the form of a guarantee
for your bank loan, or reduced establishment
costs. These are generally repaid by increase
royalty and are usually at a higher rate
than bank finance.

Other
forms of finance are equity investors and
venture capital. These entities will generally
lend money to more risky ventures than the
banks however, the trade off is that they
will charge significantly higher fees. Venture
capitalists also only fund a small proportion
of the deals that they see each year. The
disadvantages are that it is hard to secure
funding and they expect high returns and
an exit strategy. As they fund higher risk
opportunities they will lose money on a
number of deals so this is factored into
the cost of your funding. If your business
is successful the financier will end up
with 20 –70% of the equity of the
company.